How to annualise a factor rate, and why you must fix the term first

You cannot annualise what has no time in it

A factor rate is a multiple. An annual rate is a speed. Converting the first into the second requires you to supply the missing piece — how long the money is out — and the answer moves violently with that input.

Illustrative only — $50,000 advanced at 1.40 repays $70,000. The cost is $20,000 in every scenario below. Only the term changes.

The method, stated so you can reproduce it

Treat the repayments as a level annuity and solve for the periodic rate that makes them worth exactly the cash you received. Then multiply that periodic rate by the number of periods in a year. That is the same construction the annual percentage rate uses in consumer lending, and it is the only conversion that accounts for the fact that you do not hold the full advance for the full term.

Four monthly payments of $17,500 against $50,000 received solves to a monthly rate of 14.9625%. Multiplied by twelve, that is an annualised 179.6%.

Eighteen monthly payments of $3,888.89 — the total divided by eighteen, with the last payment absorbing the rounding — against the same $50,000 solves to a monthly rate of 3.8099%, an annualised 45.7%.

Same funder, same money, same $20,000 of cost. One hundred and thirty-four percentage points apart.

Why the quick method understates it

The arithmetic most people do in their head is cost divided by advance, scaled to a year: 40% x 12/4 = 120% at four months, and 40% x 12/18 = 26.7% at eighteen.

Both are too low, and the reason is structural rather than a rounding issue. You do not have $50,000 for four months. You have $50,000 on day one, and by the final payment you have almost none of it, because you have been handing it back the whole time. Averaging over the balance you actually held raises the rate. The flat method is a useful sanity check and a bad basis for a decision. If you quote it, say which method you used.

Daily debits move the number again

Most advances do not repay monthly. Counting 21 banking days a month and 252 in a year, the four-month case becomes 84 debits of $833.33. Solving the same way gives a daily rate of 0.84388%, which annualises to 212.7% — thirty-three points above the monthly-payment version of the identical deal, because the money comes back faster inside each month.

The eighteen-month case, 378 debits of $185.19, solves to 0.18888% a day, or 47.6% annualised.

If you want a single figure that captures compounding rather than the nominal convention, raise one plus the periodic rate to the number of periods. The four-month monthly case gives an effective annual rate of 432.9%; the eighteen-month case gives 56.6%. Nominal and effective are both defensible. Mixing them in a comparison is not.

Fees move the answer, and they move short deals most

Everything above solves against the $50,000 advanced. If a fee is deducted at funding, that is not the money you received.

Illustrative only — the same 1.40 on $50,000 with $1,500 taken at closing, so $48,500 arrives.

The four-month daily case, 84 debits of $833.33: solving against the $50,000 gives 212.7%, and solving against the $48,500 you actually got gives 233.4%. A 3% fee added 20.7 percentage points.

The eighteen-month case, 378 debits of $185.19: 47.6% against the advance, 52.2% against the net. The identical fee added 4.6 points, because it is spread across four and a half times as long.

That asymmetry is worth holding on to. The same dollar fee does far more damage to a short deal's annualised cost than to a long one's, while costing you exactly the same dollars. Solve against the wire, every time.

Which term do you use when the term is not fixed

On a product that remits a percentage of deposits, there is no contractual term at all. The holdback and your sales decide when the balance clears, so any annualised figure is an estimate built on a sales forecast.

This is not a technicality. If revenue runs below plan and the same total takes fourteen months instead of nine, the annualised cost falls while your dollar cost stays exactly the same. A slower repayment is easier on the account and looks cheaper on an annualised basis, and neither of those facts makes the deal better than it was on the day you signed. The dollar total is the figure that does not move.

New York's Commercial Finance Disclosure Law, in NY Financial Services Law article 8, and California's commercial financing disclosure rules under SB 1235 and the DFPI regulations both address this by requiring covered providers to disclose an APR or an estimated APR, with sales-based financing estimated from projected volume. Check the current text and whether your transaction is covered, because coverage turns on transaction size, product type and where the business is.

What to do with the number once you have it

Use it for one job: comparing an offer priced as a multiple against an offer priced as a rate, on a term you have fixed yourself and applied to both. Then put it away.

For every other purpose the better figures are the ones you cannot argue with — the total repayment, the cash that reached your account, and the payment per week. An annualised rate is a translation. A translation is only as good as the assumption you fed it, and on this product the assumption is the term.

• Fix the term first, in writing if you can.
• Solve for the periodic rate on the cash you actually received, not on the amount funded.
• State whether you multiplied (nominal) or compounded (effective).
• State the payment frequency you assumed, because daily and monthly on the same deal are not the same rate.
• Run both candidate terms — the optimistic one and the one where sales are flat — through the calculators, and quote the pair rather than a single number.